Tuesday, August 22, 2017

Chain splits under a Bitcoin monetary standard

The recent bitcoin chain split got me thinking again about bitcoin-as-money, specifically as a unit of account. If bitcoin were to serve as a major pricing unit for commerce on the internet, we'd have to get used to some very strange macroeconomic effects every time a chain split occurred. In this post I investigate what this would look like.

While true believers claim that bitcoin's destiny is to replace the U.S. dollar, bitcoin has a long way to go. For one, it hasn't yet become a generally-accepted medium of exchange. People who own it are too afraid to spend it lest they miss out on the next boom in its price, and would-be recipients are too shy to accept it given its incredible volatility. So usage of bitcoin has been confined to a very narrow range of transactions.

But let's say that down the road bitcoin does become a generally-accepted medium of exchange. The next stage to becoming a full fledged currency like the U.S. dollar involves becoming a unit of account—and here things get down right odd.

A unit of account is the sign, or unit, used to express prices. When merchants set prices in a given unit of account, they tend to keep these prices sticky for a while. A few of the world's major units of account include the $, £, €, and ¥. These units of account are conventional ones because there is an underlying physical or digital token that represents them. The $, for instance, is twinned with a set of paper banknotes issued by the Federal Reserve, while ¥ is defined by the Bank of Japan's paper media. Unconventional units of account do not have underlying tokens, but I'll get to these later.

So let's go ahead and imagine that bitcoin had succeeded in becoming the unit of account on the internet. The most commonly heard complaint of bitcoin-as-unit of account—a bitcoin standard so to say—is that it would be inflexible, more so than even the gold standard. It would certainly be more volatile, since the supply of bitcoin—unlike gold—can't be increased in response to prices. And those are fair criticisms. But there's a less-talked about drawback of a bitcoin standard: when a chain split occurs, all sorts of confusing things begin to happen that wouldn't occur in a conventional monetary system.

For those not following the cryptocurrency market, a chain split is when a new cryptocurrency is created by piggy-backing off an existing cryptocurrency's record of transactions, or blockchain, thus creating two blockchains. Luckily for us, a bitcoin chain split occurred earlier this month and provides us with some grist for our analytical mill. On August 1, 2017 anyone who owned some bitcoins suddenly found that not only did they own the same quantity of bitcoins as they did on July 31, but they had been gifted an equal number of "bonus" tokens called Bitcoin Cash, henceforth BCH. Both cryptocurrencies share the same transaction history up till July 31, but all subsequent blocks of transaction added since then have been unique to each chain.

This doesn't seem to be a one-off event. Having just passed through a split this August it is likely that Bitcoin will undergo another one in November. The history of Bitcoin is starting to resemble that of Christianity; a series of contentious schisms leading to new offshoots, more schisms, and more offshoots:

Here's the problem with chain splits. Say that you are a retailer who sells Toyotas using bitcoin, or BTC, as your unit of account. You set your price at 10 BTC. And then a chain split occurs. Now everyone who comes into your shop holds not only x BTC but also x units of Bitcoin Cash. How will your set your prices post-split?

The most interesting thing here is that an old bitcoin is not the same thing as a new bitcoin. Old bitcoins contained the entire value of Bitcoin Cash in them. After all, the August 1st chain split was telegraphed many months ahead—so everyone who held a few bitcoins knew well in advance that they would be getting a bonus of Bitcoin Cash. Because a pre-split price for the soon-to-be tokens of $300ish had been established in a futures market, people even knew the approximate value of that bonus. This anticipated value would have been "baked into" the current price of bitcoins, as Jian Li explain here. Then, once the split had occurred and Bitcoin Cash had officially diverged from the parent Bitcoin chain, the price of bitcoins would have fallen since they no longer contained an implicit right to get new Bitcoin Cash tokens.

Thus, BTCa = BTCb + BCH, or old bitcoins equals the combined value of new bitcoins and Bitcoin Cash.*

As a Toyota salesperson, you'd want to preserve your margins throughout the entire splitting process. In the post-split world, if you continue to accept 10 BTC per Toyota you'll actually be making less than before. After all, if one BTC is worth ten BCH in the market, then a post-split bitcoin—which is no longer impregnated with a unit of BCH—is worth just nine-tenths of a pre-split bitcoin. In real terms, your income is 10% less than what is was pre-split.

You have two options for maintaining your relative position. Option A is to continue to price in current BTC, but jack up your sticker price by 10% to 11 BTC. Customers will now owe you more bitcoins per Toyota, but this only counterbalances the fact that the bitcoins you're getting no longer have valuable BCH baked into them.

This would make for quite an odd monetary system relative to the one we have now. If everyone does the same thing that you do—mark up their sticker prices the moment a split occurs—the economy-wide consumer price level will experience a one-time shot of inflation. Given that bitcoin schisms will probably occur every few years or so, the long-term price level would be characterized by a series of sudden price bursts, the size depending on how valuable the new token is. When splits are extremely contentious, and the new token is worth just a shade less than the existing bitcoin token, the price level will have to double overnight. That's quite an adjustment!

We don't get these sorts of inflationary spasms in modern monetary systems because there is no precise analogy to a chain split. When August 1st rolled around, Bitcoin supporters could not invoke a set of laws to prevent Bitcoin Cash from being created on top of the legacy blockchain. In fiat land, however, a set of actors cannot simply "fork" the Canadian dollar or the Chinese yuan and get off scot-free. The authorities will invoke anti-counterfeiting laws, which come with very heavy jail sentences.**

The closest we get to chain splits in the real world are when the monetary authorities decide to undergo note redenominations. Central bankers in economies experiencing high inflation will sometimes call in—say—all $1,000,000 banknotes and replace them with $10 banknotes. And to compensate for this lopping-off of zeroes, merchants will chop price by 99.999% overnight. But redenominations are very rare, especially in developed countries. Up until it dollarized in 2008, even Zimbabwe only experienced three of them. Under a bitcoin standard, they'd be regular events.

Option B for preserving your relative position is to keep a sticker price of 10 per Toyota, but to update your shop's policy to indicate that your unit of account is BTCa, or old bitcoin, not new bitcoin. Old bitcoin is just an abstract concept, an idea. After all, with the split having been completed, bitcoins with BCH "baked in" do not actually exist anymore. But an implicit old bitcoin price can still be inferred from market exchange rates. When a customer wants to buy a Toyota, they will have to look up the exchange rate between BTCa and new bitcoin (i.e BTCb), and then offer to pay the correct amount of BTCb.

To buy a Toyota that is priced at 10 BTCa, your customer will have to transfer you 10 new bitcoins plus the market value of ten BCH tokens (i.e. 1 bitcoin), for a total price of 11 bitcoins. This effectively synthesizes the amount you would have received pre-split. As the market price of Bitcoin Cash ebbs and flows, your BTCa sticker price stays constant—but your customer will have to pay you either more or less BTCb to settle the deal.

The idea of adopting a unit of account that has no underlying physical or digital token might sound odd, but it isn't without precedent. As I pointed out earlier in this post, our world is characterized by both conventional units of account like the yen or euro and unconventional units of account. Take the Haitian dollar, which is used by Haitians to communicate prices. There is no underlying Haitian dollar monetary instrument. Once a Haitian merchant and her customer have decided on the Haitian dollar price for something, they settle the exchange using an entirely different instrument, the Haitian gourde. The gourde is an actual monetary instrument issued by the nation's central bank that comes in the form of banknotes and coins.***

So in Haiti, the nation's unit of account—the Haitian dollar—and its medium of exchange—the gourde—have effectively been separated from each other. (In my recent post on Dictionary Money, I spotlighted some other examples of this phenomenon.) An even better example of separation between medium and unit is medieval ghost money. According to John Munro (link below), a ghost money was a "once highly favoured coin of the past that no longer circulated." Because these ghost monies had an unchanging amount of gold in them, people preferred to set prices in them rather than new, and lighter, coins, even though the ghost coins had long since ceased to exist.

Unlike option A, which would be characterized by a series of inflationary blips each time a split occurred, option B provides a relatively flat price level over time. After all, the old bitcoin price of goods and services stays constant through each split. However, as the series of chain splits grows, the calculation for determining the amount of new bitcoins inherent in an old bitcoin would get lengthier. In the example above, I showed how to calculate how many bitcoins to use after just one chain split. But after ten or eleven splits, that calculation gets downright cumbersome.

Whether option A or B is adopted, or some mish-mash of the two, a bitcoin standard would be an awkward thing, the economy being thrown into an uproar every time a chain schism occurs as millions of economic actors madly reformat their sticker prices in order to preserve the real value of payments. If bitcoin is to take its place as money, it is likely that it will have to cede the vital unit of account function to good old non-splittable U.S. dollars, yen, and other central bank fiat units. The Bitcoin community is just too sectarian to be trusted with the task of ensuring that the ruler we all use for measuring prices stays more or less steady.

P.S.: I've focusing on sticker prices here, I haven't even touched on contracts denominated in bitcoin units of account. For instance, if I pay 10 BTC per month in rent for my apartment, what do I owe after a split? Ten old bitcoins? Ten new bitcoins? Or would I have to transfer 10 new bitcoin along with 10 units of Bitcoin Cash? Who determines this? What about salaries? The problem of contracts isn't merely theoretical, it actually popped up in the recent split as some confusion emerged on how to deal with to bitcoin-denominated debts used to fund short sales. Matt Levine investigated this here.

*There is also the complicating fact that the price of bitcoin didn't seem to fall by the price of Bitcoin Cash, thus contradicting the formula. As Matt Levine recounts:

In a spinoff, you'd expect the original company's value to drop by roughly the value of the spun-off company, which after all it doesn't own any more. 5 BCH spun off from BTC on Tuesday afternoon, and briefly traded over $700 on Wednesday (though it later fell significantly). But BTC hasn't really lost any value since the spinoff, still trading at about $2,700. So just before the spinoff, if you had a bitcoin, you had a bitcoin worth about $2,700. Now, you have a BTC worth about $2,700, and also a BCH worth as much as $700. It's weird free money, if you owned bitcoins yesterday.

**Say
counterfeiters do manage to create a large amount of fakes. Even then this
"fiat split" would have no effect on the value of genuine notes. Central
bank are obligated to uphold the purchasing power of their note issue.
They will filter out fakes be refusing to repurchase them with assets,
the purchasing power of counterfeits quickly falling to zero, or at
least to a large discount. When central banks are fooled by counterfeits
they will use up their stock of assets as they erroneously repurchase fakes. But even
then they will never lose the ability to uphold the value of banknotes
as long as the government backs them up with transfers of tax revenues.
Fiat chain splits only begin to have the same sort of effects as
bitcoin chain splits when 1) counterfeiting goes unpunished; 2) the central
bank can't tell the difference between which notes are genuine and which
are fakes; and 3) it lacks the firepower and government support necessary
to buy back paper money in sufficient quantity. Only at this point will counterfeiters succeed in driving the economy's price level higher.This, by the way, is what the Somali shilling looks like... a fiat currency constantly undergoing chain splits.

*** I get my information on Haiti from this excellent paper by Frederico Neiburg.

35 comments:

Here's a modification to your counterfeiting analogy. Say the Canadian government is in turmoil. Institutions muddle along, the economy is growing, no disorder in the streets—but most people recognize the centre might not hold without big reforms. Some group of enterprising citizens decides to try to get ahead of the worst outcomes by founding a Government in Waiting. This includes a Bank of Canada in Waiting with full note printing capabilities.

The notes this bank prints—call them CWAD—aren't really counterfeits: nobody would mistake them for the real thing. Nor are they redeemable for anything. Rather, their value ought to derive from people's uncertainty about the Canadian government along with a rough credibility assessment of the Government in Waiting. A hedge against regime failure, if you like. (The real government meanwhile tries to project strength by laughing all this off instead of shutting it down.)

So the Government in Waiting announces a massive note issue taking the form of a dollar-for-dollar helicopter drop on all Canadians on a set date. They get to work implementing a clone monetary policy and staffing up clone Ministries, a clone Parliament, etc. The hedge looks credible. CWAD notes trade above zero. Or maybe the hedge doesn't look credible but every Canadian is a sudden speculator out searching for the greater fool before the price crashes; remains to be seen.

Parallel to this circulation of 'hedges', Canadian merchants aren't changing their unit of account and they aren't fiddling with sticker prices. Forex traders, confident they've already priced in possible regime failure, aren't selling off CAD—maybe the average trader would prefer to buy CAD the day before the CWAD drop than the day after, but the fundamental demand trend doesn't change. Some CAD debt contacts get disputed around the edges and that's it.

Now economists are puzzled: how can CWAD + CAD keep trading above CAD alone without CAD falling in price? Where did this magical surplus come from? My answer would be this: CWAD's long run value, if not zero, is limited to the economic value of this group standing ready to replace the current regime, or somehow pivoting to the provision of useful public services that the main regime can't deliver.

What do we find on the LHS of the balance sheet of the BoC in Waiting (to match the notes on the RHS)? Would that be (implicit) Government in Waiting debt? Would the Gov in Waiting stand ready to redeem the notes only in case it acquires the ability to impose taxes?

I think my answer would depend on people's expectations surrounding what monetary policy the Government in Waiting will adopt should a regime switch occur. Will it refuse to accept CAD notes as a liability or will it accept them? If so, will it have the wherewithal and desire to continue with the existing inflation target for CAD? Finally, will it demonetize CWAD and buy them back 1:1 with CAD (or vice versa), or adopt a 1:1 peg between CWAD and CAD?

If people assume that the Government in Waiting will commit to supporting CAD (i.e. adopt it as their liability), and that it has the resources (i.e. tax revenues) to stick to the old government's inflation target for CAD, and that it will credibly peg the two note brands at a 1:1 ratio, then that would explain why there is a magical surplus (rather than each currency splitting the difference).

This is where the forked blockchain metaphor gets too convoluted. Unlike a public blockchain, the BoC in Waiting's balance sheet would be centralized, and its monetary policy set by named decisionmakers. The public would want to closely scrutinize both. And unlike the Bitcoin Cash or Ethereum Classic projects, which appear to be running on idle computing resources and volunteers' free time at the outset, the Government in Waiting would need major funding for its operations. They could issue bonds, or run special CWAD printings (a "currency presale", say) in direct exchange for other assets they need. But these financing rounds would force a level of transparency and credibility not present in blockchain forks. What's the plan to build a tax base (Canada Revenue Agency in Waiting, get busy); what monetary and fiscal policies will be implemented day one after a regime takeover; what about the legislative calendar, elections, etc.? I think there are analogous governance design questions for these fly-by-night blockchain projects that simply never get asked because everyone in that ecosystem is partying like it's 1999.

JP, great point about CWAD:CAD pegging. Regime collapses tend to be sudden, cascading events. So it wouldn't be very credible to say to all the CAD holders in the new economy, "sorry, you were betting on the wrong horse". That would be macroeconomic suicide.

Back in blockchain land, though, nobody has brought up the idea of a post-split peg for any of these new currencies were they to someday fulfill their stated aims. If a code flaw in Bitcoin caused the network to crash, or if a crisis of confidence moved all institutional resources away from Bitcoin and into Bitcoin Cash in a matter of weeks, I think the price of BTC would indeed fall to zero: no peg, no bailouts. If the blockchain economy gets orders of magnitude larger and becomes systemically significant to the rest of the economy, you can bet attitudes on that will change.

Large bitcoin banks let us park our personal bitcoins and withdraw custodial bitcoins in the banks name. The result is mastercharge exactly. But the large banks control the forks, they control the ledger queue to blockchain as all the small accounts are parked. Further, the large banks can clear custodial bitcoins at par, as long as the blockchain ledger queue is stable for each. They do not need to make a blockchain call for each transaction.

That was the big Microsoft announcement, they used secure hardware to create lateral clearing system that still maintain the block chain, but consortium members close most of the payment loops with lateral clearing like banks do today.

I don't understand. You're saying that if I want to send my bitcoin from one bitcoin bank to another, the blockchain isn't being used? Rather, banks are swapping IOUs? If so, how does this have anything to do with who controls forks?

I am not the real expert on forks but they vote to fork comes from transactions with the blockchain. If a few large banks control that portal to the blockchain then they minimize the fork size and likelihood of a fork; they have the votes. So, let the eight large banks, if they wish, form eight large 'side chains' each side chain being a custodial coin. Since the clear laterally, their clearing speeds are an order of magnitude faster than the block chain. The large banks control monetary flow, they have issued the major credit cards, the cards support money market funds in the bitcoin side chain. The large banks call the block chain when accounts check in or out. So, they have geared the calls to block chain way down.

Have you thought about banks using BTC as a unit of account? Once that happened there would be no shortage of money, and eventually the original Bitcoins would fade into obscurity. They would be remembered as some silly collectibles that gave the name for our unit of account (this wouldn't be different from our current units of account, the history of which you are surely more familiar with than I am).

Your post left me also wondering how would BCH be used in an economy where BTC was so dominant? If I, in 1996, had suddenly got a Betamax duplicate for every VHS cassette I owned, I would probably just have dumped them in the attic.

I only now saw that Matt Young's comment above was related to mine, as it dealt with bitcoin banks (which I'm unfamiliar with). What I'm after is JP Morgan, BoA, Citi and others doing their bookkeeping in BTC units, and not, say, USD.

In the case of the gold standard, bank deposits denominated in gold would have reduced the demand for gold, pressuring the gold price down and inversely pushing the price level up. But this inflation would have been halted by manufacturers who, attracted by a lower gold price, would have drawn gold out of circulation. In the case of bitcoin, there is no industrial demand--so the price of bitcoin collapses to zero as bitcoin deposits grow.

"Your post left me also wondering how would BCH be used in an economy where BTC was so dominant?"

JP, this feels paradoxical, I need more convincing! Did the growth of fractional reserve banking on a decentralized gold standard in places like Canada and Scotland correspond to great surges in price levels as demand for banknotes sapped demand for the base money they were denominated in? Are there recorded instances in the last few hundred years of gold falling close to industrial value, i.e., no "moneyness" premium left?

I would avoid using the misleading word "deposit", now that we finally have a chance.

Yes, initially it might be the case that banks would hold a reserve of bitcoins, which they bought (note: instead of accepting a deposit, the bank took the ownership of the bitcoin) from non-banks. These non-banks were willing to hold a credit balance denominated in BTC in the bank's ledger, because the bank paid some interest on that balance. The majority of the credit balances, though, came into existence because people took on debt (mortgages, etc).

If prices of goods (incl. services; salaries) are denominated in BTC, why would the price level rise if new credit balances are created? I don't think it would, unless demand for goods significantly increased.

Later, in case of any bank runs, the government would establish a moratorium on bitcoin withdrawals.

I don't think it would be a bitcoin standard. Bitcoin standard would see the price of bitcoin being set at a certain dollar amount. Dollar was the unit of account during the gold standard. But now we are talking about BTC being the unit of account.

Jason: I'm just working out the theory. It's tough to point to specific examples of increases in the price level caused by substitution from base money to deposits given that the price level is affected by so many different factors.

Antti: "I would avoid using the misleading word "deposit", now that we finally have a chance."

Whoops, I think I misunderstood your original comment from 2:45, then.

I wouldn't give too much credence in the "baked-in" analogy. While it does make sense that a part of hashing power is moving from working on specifically BTC to now working on BCH, the "baked-in" price was completely unknown until the moment of the split (actually a few hours afterwards when blocks were finally mined). Unlike Paypal/EBay which the traditional methods of valuing stocks play their roles to determine Paypal stock price, and the subtraction of that price from Ebay to determine two separate prices for two separate companies, BTC and BCH do not have those methods. Their prices are not determined by their dividend payout, claim on assets after debt, etc.

This being said I don't think the before/after split prices are inversely or directly related to the amount of hashing power leaving BTC for BCH, so merchants selling a Toyota are not seeing the value of their BTC decrease by the splits price, because the presplit price did not have the BCH price(unknown) baked in. What does seem more plausible (and what actually happened) was the price of presplit BTC hovered lower due to uncertainty of the split, not higher (then dropping lower) with the belief of BCH added value.

I think with uncertainty of future splits we will generally see BTC price sit at some type of support level (lower) and then when things are over, its price move back to where it would be. Toyota would likely raise prices in BTC had the August 1st split been more in line with ETH/ETC as the uncertainty was far higher. Generally sellers do not fluctuate prices with the swings in forex markets.

But even if there wasn't, I'd argue that people don't need a specific market to break out the price of a good or asset that is embedded in another asset. For instance, a consumer has a good feeling for how much more they'll pay for a house with a mountain view relative to one that doesn't, even though there is no independent market for "mountain views."

"Their prices are not determined by their dividend payout, claim on assets after debt, etc."

We can agree that the price of gold is not determined by the sorts of methods used to value stocks like Paypal, right?

But if God suddenly decrees that all gold Eagles are going to magically throw off a new gold coin tomorrow, then the market will drive up the price of Eagles by the expected value of the new gold coin. And once the magic event has transpired, the market price of those Eagles will fall in value by the price of the new gold coin, because they no longer promise to throw off a new gold coin.

If you can tell me why I'm wrong with my gold coin story then that might help me understand why I shouldn't apply the "baked in" analogy to bitcoin splits. They seem like pretty much the same thing to me.

"a bitcoin standard would be an awkward thing, the economy being thrown into an uproar every time a chain schism occurs as millions of economic actors madly reformat their sticker prices in order to preserve the real value of payments."

Forgot to add this. If you look at a split for what it is, a divergence of hashing power from one currency to another, the prices of goods do not need to be constantly adjusted (so long as the split doesn't destroy the currency, like losing so much of its hashing power that transaction times are delayed days or longer)

I think of it in this way: If a small US credit union decides to move to Europe and only use Euros, it certainly has an effect on the availability of USD and credit in an area but does not collapse the dollar in all areas because it is small. It is a part of the entire ecosystem for that currency and therefore its loss should be felt, but it isn't, this would be compared to a single miner leaving BTC for another coin. If on the other hand a major bank decides to move and only deal in Euro, that will directly affect the USD and credit availability, like our forks where percentages of miners leave together at the same time to work on another coin. A split is taking that institutions power and benefits provided to that currency and allocating it to another currency instead. It presumably would have an effect on credit availability and money supply but it does not, why?

Most likely because of monetary policy adjustments are made to handle the loss of institutional power available. If there are less banks available to lend, the Fed can lower the reserve ratio and allow banks to lend more of their money to cover the "missing money" or some other tool. Bitcoin and many other Cryptocurrencies may not do this with increasing money supplies(kind of, miners are still rewarded with "Newly minted Bitcoin") but they do this with Block difficulty and rewards. If a split takes a decent chunk of hashing power the block difficulty goes down and the reward is greater for the remaining miners. This allows miners (institutions) to handle more transactions and get rewarded appropriately for the increased load. It also makes the mining market more profitable and more miners can come in.

in conclusion: the price of BTC does not have the value of a fork "baked in" as it theoretically would have to have the value of every hard fork ever baked in, and the institutional loss of a hard fork has little effect on the use and value of the currency as it's designed to adjust for miner fluctuations.

This is all assuming the prices have found some type of stability that Toyota feels comfortable in pricing in it.

"But if God suddenly decrees that all gold Eagles are going to magically throw off a new gold coin tomorrow, then the market will drive up the price of Eagles by the expected value of the new gold coin. And once the magic event has transpired, the market price of those Eagles will fall in value by the price of the new gold coin, because they no longer promise to throw off a new gold coin."

Well the gold eagle is not throwing off a new Gold coin, it's throwing off a coin that is not fungible with the original eagle, but that is also not something that is already in existence, so we can't say silver (otherwise it's price would be valued in silver) we would have to say something like Mithril (Is that real?) and that Mithril would have to be in exact quantities of those gold coins. Anyway, I just needed to adjust your analogy a bit.

The market then has no idea what Mithril is worth, though they know it's relative quantity available, when it will be available and the rules it will play by. They do not know what it will be traded for, if it will be accepted by anyone, what exchanges will accept it, if it will be lossed in hot wallets (accounts where they will not be able to receive and control the mithril) and probably most importantly they do not know if it will REPLACE the Gold eagle as Gods De-facto coin.

Additionally we need to think of this Gold eagle as having LOST something in this creation of the mithril coin. This last point is what creates uncertainty. Just how much of that something will the Gold Eagle lose in order to create the Mithril coin, and will the mithril coin be worth more than the Gold Eagle. This uncertainty, I believe, is why we saw price of BTC actually sit at lower support levels leading up to the split. People, instead of buying gold eagles and pushing the price up to the expected value of the additional mithril coins, actually opted out for fear that the creation of the Mithril coins would destroy the gold eagle.

I first thought JP might be right, but now I find Anonymous's argument more convincing.

Valuing BTC and BCH is one hell of a mess. Wild speculation, without any anchors. The price of BTCa might, as Anonymous suggests, dive first because of concerns about the future of BTC, only to experience some kind of relief rally after the introduction of BCH. I say "introduction of BCH" and not split, or spin-off, or whatever, because as Anonymous says, any split there is is a split in the infrastructure (hashing power), not in BTC per se.

I don't think we can really think of this as some kind of whole (BTCa) being divided into two parts (BTCb+BCH), can we? It's more like an introduction of yet one new cryptocurrency, which happens to be distributed to the owners of BTC.

I was initially very sympathetic towards JP's theoretical point about there being a premium on BTC before BCH is introduced (as there had already been established some kind of market price for BCH), but as I said, there are no anchors, and so the (ex post) price of BTC and BCH was anyone's guess.

"The market then has no idea what Mithril is worth, though they know it's relative quantity available, when it will be available and the rules it will play by. They do not know what it will be traded for, if it will be accepted by anyone, what exchanges will accept it, if it will be lossed in hot wallets (accounts where they will not be able to receive and control the mithril) and probably most importantly they do not know if it will REPLACE the Gold eagle as Gods De-facto coin."

You say that the market would have no idea what Mithril is worth, but say a futures market emerged to discover the price of the Mithril coin, sort of like the BCH futures market that ViaBTC set up, then that solves that problem, no?

JP, we have to remember we are in the midst of a speculative frenzy here. You and I seem to agree that all these coins should probably be worth zero.

If BTC is priced at $3,000 on the day before BCH introduction, and BCH on the futures market trades at $300, then what should the price of BTC and BCH be next day? It's anyone's guess. It's not like BTC has somehow become exactly $300 less valuable (although I fully understand the logic you follow; the problem is, there's no logic in the pricing of this stuff).

A new day, a new price. The people on the futures market were betting on the price of BCH, but on the day of introduction they were pricetakers like anyone else.

(Of course I feel like an idiot saying what I say above, but I'm just trying to get into the head of people who invest in this stuff.)

" (although I fully understand the logic you follow; the problem is, there's no logic in the pricing of this stuff)."

That's a fair argument. We shouldn't expect to much rationality during a frenzy. If people are logical enough to price in a chain split, then they should also be logical enough to see bitcoin has a fundamental value of zero. Since they don't price bitcoin at zero, we shouldn't expect them to properly account for the split.

This is where I differ from you two. I'd bet long on a few of these coins being worth something even after the bubble pops and speculators leave. JP has talked about an ideologically motivated "Bitcoin plunge patrol" holding up the price, but I think it goes deeper than that. Demand for a borderless digital store of value looks durable. Black and grey market demand for a wire service not run by banks looks durable. If some of the next gen Internet projects being built on Ethereum come to life, such as cheap distributed file storage or uncensorable prediction markets, that's real value creation.

Don't get me wrong, it's 1999 in blockchain land. This is going to be a bloodbath. But like an dot-com bear laughing at the idiot VCs who gave money those two Stanford grads to go create the 37th search engine, it's easy to lose sight of opportunity amid madness.

"it's 1999 in blockchain land" Crypto Market cap is about $150b compared to dotcom bubble of well into the trillions. If crypto pops it wont take the entire economy with it like dot com bubble. hell Apple has more than twice as much CASH than the entire cryptocurrency market cap. So I think crypto has a long way to go before it can be compared to the Dot com bubble.

"You say that the market would have no idea what Mithril is worth, but say a futures market emerged to discover the price of the Mithril coin, sort of like the BCH futures market that ViaBTC set up, then that solves that problem, no?"

I don't believe so, no. Problem with the futures markets, and early post fork trading, is that there were many variables that make any accurate estimate of the potential price unpredictable and futures unreliable. For instance most (possibly even all) exchanges that were initially supporting the BCH chain or futures had only supported BCH internally, meaning for BTC accounts held on site, and did not open deposits or withdrawals until much later. This effectively locked supplies of BCH available on an exchange but allowed anyone on the exchange to try and purchase that limited BCH. This floats the price, and prevents arbitrage opportunities by moving BCH to higher priced exchanges. Because volume was limited on these higher priced sites (some trading $300 higher than others, had few BCH in volume, this was denoted by an asterisk on Coinmarketcap.com) it also allowed the price to stay "stuck" at a high level, a few trolls had jokingly opened up a futures market for BCH on a decentralized exchange and traded back and forth for up to 10X the price on other exchanges, until someone else on the site bit on the inflated price and couldn't sell it because the buyers disappeared.

Along with the locked supplies (but tradeable) is locked supplies (untradeable) these include any and all bitcoin wallets off exchanges (as exchanges locked deposits of BCH) and also BTC held on exchanges that would not host BCH (coinbase, Poloniex, etc). This meant that the available supply of BCH was even smaller than BTC. All these culminate into an incredibly complex and inaccurate method of pricing for a coin, making the Baked-in idea less likely as futures from different sites had different prices and so on, so that BTC price (if people attempted to bake in BCH) would have no clear indicator of a price to bake in.

Along with this Futures market disparity is, as I said, the potential loss of infrastructure for BTC during the hardfork. Essentially hashing power leaves BTC to work on BCH blockchain and depending on how much ultimately decides to leave (on fork day) there is no telling how BTC or BCH price/functionality would work. Which leads to uncertainty and decrease in buy orders and increase in sell orders, lower BTC price prefork and higher prices post fork when it was determined the scale of damage done to BTC afterwards. Or in other words the exact opposite of the effects of traditional baked-in theory (I'm not sure how traditional baked in is?).

I think the baked-in method applies well for shares of companies breaking their stock into two separate stocks, or two separate companies, as the assets can be known for the split (though speculative nature will of course play its part). I think a major factor of the pricing is the fact that splits of companies will likely list both stocks on a single exchange, and that exchange be a major one (NYSE, Nasdaq) which removes the barriers that we see with these hundreds of exchanges for Cryptocurrencies, and doesn't allow for arbitrage, or in BTC/BCH case, restrict arbitrage. The baked-in method works, I just don't think it's applicable in this case.

I think we will see cryptocurrencies gaining more "value" the more we see the crypto market moving away from simply currencies and more to blockchain assets. The Hybrid coins will do the best (Ethereum, I say this because ERC20 and ERC23 assets use Ethereum as "gas" to send their tokens, the success of these other tokens directly results in the success of Ethereum. Like Ford sales benefiting oil suppliers.) though even Bitcoin is having a smart contract layer being built for it that wont require a fork (research Rootstock or RSK). But we are seeing businesses springing up giving real world applications to blockchain technologies that is more than just a medium of exchange, Golem provides Fog computing power, Augur is making wisdom-of-the-crowd prediction markets, Factom is creating auditable record keeping and notary services, Ripple is providing interbank transfers like SWIFT, Komodo (Supernet) is working on anchoring multiple blockchains and currencies to one another for more security and privacy, each one of these can gain value in traditional markets for their services or products as well as their gains in the crypto markets. It's going to be a wild ride, but I think crypto isn't as big as we make it out to be, not yet anyway.

"All these culminate into an incredibly complex and inaccurate method of pricing for a coin, making the Baked-in idea less likely as futures from different sites had different prices and so on, so that BTC price (if people attempted to bake in BCH) would have no clear indicator of a price to bake in."

Oh, no doubt. It was a complex process, and you give a lot of nice institutional detail.

But you go too far in saying people have *no idea* about these things. Markets find prices for future events all the time (just look at how prediction markets can arrive at a full set of prices for 2020 presidential candidates). While the price that would have been baked into bitcoin pre-split required inaccurate methods, some sort of price would have nevertheless been baked in. *No idea* implies that the market was content to assume that no premium whatsoever was built into bitcoin going into the event i.e. it assumes a free lunch.

I'm sure some thought of it as a free lunch, but what I am trying to show is that it was more of a fear that BCH would actually damage BTC, resulting in two individually weaker currencies. BCH and BTCb both being less valuable and weaker than BTCa, even if combined.

The problem I see is that future markets existed in multiple different areas and due to deposit/withdraw restrictions were essentially in isolation from one another (and devoid of arbitrage). These price disparities mean that the BTC being traded could not have a baked-in price, or if it did, it was not at all consistent as some one could bake in BCH value from one future market while someone else could bake in the value from another. All while others simply shorted it. (I would love to get my hands on Bitcoin shorts data prior to the fork).

If the futures markets truly were used as baked in prices, we would have seen BTC trading at over $900 its post fork price, or a different rate that held more volume, etc. Which did not happen. What happened instead was BTC trading slowed leading up to BCH, and price actually decreased, most likely due to uncertainty of how big a fork this would be; and what damage it would have on BTC.

There was rumors among many of the traders (more like FUD) that someone like Roger Ver, who is a strong BCH proponent and took his side in the "Bitcoin Civil War", has allegedly 100,000 BTC and could take advantage of the shallow markets prefork and the increased block size, move his entire fortune to exchanges and single handedly sink BTC to $1 after the fork, while doubling his BCH supply. Thankfully that didn't happen, but we had entire teams trying to track his accounts on the blockchain to provide early warning if he made major moves.

"implies that the market was content to assume that no premium whatsoever was built into bitcoin going into the event i.e. it assumes a free lunch."Or that there was no premium built in because hard forks are inherently damaging to the original currency. Hard forks themselves require miners and nodes to leave the original currency to work on the new one. I don't believe that the prices and volumes show that traders saw BTC as having BCH baked in and having a free lunch, but instead looked at BCH as being ripped out of the real value of BTC. damaging both currencies and making them both worse off than prefork.

"...but instead looked at BCH as being ripped out of the real value of BTC."

Ok, let's rethink this.

Bitcoin is worth $1000. A BCH split is proposed. A well designed and fully accessible futures market for BCH is established. The price of BCH in that market rises from $0 to $300.

There are two responses that delimit the extent to which the price of pre-split bitcoin will move. A: the price of pre-split bitcoin falls by $300 to $700 as the expected value of the BCH is "ripped" out of it. Or, B: the price of pre-split bitcoin rises by $300 to $1300 as the expected value of BCH is "baked" into it.

The split occurs. If A, the price of BTC immediately falls from $700 to $400. If B, the price of BTC falls from $1300 to $1000. For both A and B, this last $300 fall has to occur to prevent a free lunch. Without it, people will buy BTC a moment before the split (paying $700 in the case of A, or $1000 in B), and exiting with a free lunch a moment after the split (getting $1000 in the case A, and $1300 in B).

If I've understood Anonymous correctly, he means that the split was by many seen as a "moment of truth" -- anything could have happened, much like when year 2000 arrived. It was all rumors and speculation.

We shouldn't expect price continuity between pre-split and post-split, as in your example. BTC and BCH prices holding up after the split should be interpreted as a sigh of relief. The world didn't end.

Excellent post,I just quibble with the term "unconventional money" and how it has no physical or digital token behind it.Isn't bitcoin - just like the Haitian dollar - just a derivative? Which means that without the underlying, i.e. conventional money, it would/could not even exist? Hence there is (or hast to be?) a link to a physical or digital token, albeit one or several steps removed.What we are observing in the Haitian and Bitcoin example can best be classified as derivative prices. People are speculating on how much dollars they will get in the future.Or am I missing something?

We use metres as a unit for measuring. You can't own 1 metre. But you can own a ruler that measures 1 meter.

Same thing with money. Both Haitian dollars and U.S. dollars are measuring units. There is no way you can own a Haitian dollar. You can, however, own a dollar bill. That's all I meant by the distinction between conventional and unconventional money.